Recession Watch: What to do with your stocks

We may or may not be headed into a recession. It depends upon which economist you believe, but it is time to assess your risk exposure and possibly reallocate your portfolio holdings. Don't panic and start selling just because you hear warnings of a recession. You may be locking in loses that are not necessary, especially if the assets in your portfolio are being held for the long-term and you won't need them for ten years or more years.

Step 1 - Take Stock of Your Stock/Mutual Fund/Bond Holdings: Review your holdings and ask yourself these questions: Did your holdings perform the way you expected them to do when you first bought them? Did they do better? Did they do worse? Do you think they are still a good choice based on your investment horizon? Is your allocation out of whack? For example, did you buy some aggressive growth stocks or mutual funds that are now a much larger portion of your portfolio than you think wise.

Step 2 - Sell any stocks or mutual funds you determine don't match your current goals: As you look through your portfolio and find holdings you really don't want any more, bite the bullet, take the loss (if there is one) and don't risk an even greater loss if we do end up in a full-blown recession. Hold on to any cash generated for buying opportunities once the current stock market correction has finished doing its damage.

Step 3 - Sell to preserve gains and reallocate your portfolio: If you do have significant gains in growth stocks or mutual funds, you may want to sell some portion of those holdings to preserve your gain and reallocate your holdings to a risk level that let's you sleep at night. This decision is easy to make if the holdings are in an IRA or other tax-deferred or tax-free vehicle. If the holdings are in a taxable portfolio, check with your tax adviser about capital gains tax exposure and whether locking in gains is a good choice for you right now. Taxes due will not have to be paid right away because any sales now would be reported on your 2008 returns. You may be able to offset gains with losses taken by selling some other holdings. Hold on to any cash generated for buying opportunities once the current stock market correction has finished doing its damage.

Step 4 - Develop a watch list: Use the time in the next few months to develop a watch list of possible future stock or mutual fund purchases. Establish target prices at which you want to buy these securities. Watch for signs that we're nearing the end of the correction and be ready to buy when you see the market is starting to head back up.

Step 5 - Buy to fill any portfolio gaps: After you've sold all the holdings you want to sell, look for buying opportunities to fill any gaps in your portfolio. For example, if you think it's time to add bonds, REITs or commodities (these can be bought using mutual funds or direct purchase of the securities or commodities), use some of your cash generated to fill any gaps and leave some for buying opportunities before the next bull starts.

No matter what you decide to do, act deliberately and cautiously. Don't sell just because you're hearing bad news. Sell to either preserve gains or cut your losses only after you're taken a careful look your entire portfolio, your time horizon for needing the money and your long- and short-term goals. If you do expect to need cash from your holdings in the next 2 to 5 years, take the cash out now and put it into something safer than stocks or stock mutual funds. If you have a 2-year horizon, money market funds or CDs are probably your best choice. If you have a 3- to 5-year horizon consider bond options.

Lita Epstein has written more than 20 books including "Trading for Dummies." This post is part of a series offering consumers advice on what to do during a recession.